The Chinese leadership is so endearing. Whenever they jump some
financial hurdle, they have Xinhua News tell us all about it. This is
good for me because it brings to attention all sorts of things we
Americans would like to ignore. This week, the Chinese have been
talking about Outbound Investment and International Investment
Positions. These are the underpinnings of our Free Trade universe.

Back in February, when he first addressed the issue of stubbornly
low bond yields, Federal Reserve Chairman Alan Greenspan called it a
"conundrum." The mystery revolved around a simple question: Why were
long-term interest rates falling even as the central bank was jacking
up short-term rates? Back then, Greenspan ventured that the anomaly
could be a temporary aberration and that in no time, bond yields might
start acting in more traditional ways.

More than three months --
and two more rate hikes -- later, bond yields have once again been
falling, surprising not only Greenspan but many market pros as well.
Indeed, in early June, yields on 10-year Treasury securities fell
sharply, to below 4%. Greenspan doesn't think the falling yields are a
sign of slower growth ahead, as many in the market believe. But even
with the economy powering ahead, he seems increasingly convinced low
bond yields may be an enduring phenomenon, driven by a complex of
international forces the Fed has yet to fully understand.

That
shift has some at the Fed entertaining hitherto heretical thoughts.
Maybe, they posit, ultralow interest rates aren't inflationary in a
global economy awash with savings and dominated by cutthroat
competition from China, India, and other developing nations. After all,
it's bond-market investors who have traditionally been most sensitive
to any whiff of inflation. If they're willing to accept low yields,
that suggests the U.S. and the global economy may be far more inflation-resistant than once thought.

*snip*

Now, it's a multifaceted set of global capital and trade flows that
the Fed is trying to decipher. Part of the puzzle is that the U.S.
isn't the only place where bond yields are low; they're down throughout
much of the world. Indeed, in many countries, including Germany and
Japan, they're even lower than in the U.S. In part, of course, that
reflects the tepid outlook for growth in many foreign economies
compared with the U.S. But everyone at the Fed seems to agree that
something else is at work as well.

In struggling to figure out
what's going on, Greenspan has focused on the increased integration of
global financial markets and the stepped-up flow of capital worldwide.
That has meant more of the world's savings can be invested across
borders rather than being locked up in individual countries, as was the
case with the former Soviet Union. As Greenspan tells it, investors'
"home bias" -- their proclivity to keep their money in their own
countries -- is diminishing, making a bigger pool of savings available
internationally for investment in more profitable and productive
ventures.

SAVINGS GLUT Some of Greenspan's colleagues at the
Fed's board, including Vice-Chairman Roger W. Ferguson Jr. and outgoing
Governor Ben S. Bernanke, have gone further. They argue that the world
is awash with savings because of slumping demand for capital in the
slow-growing economies of Europe and Japan and a buildup of currency
reserves by China and other emerging Asian nations. Moreover, that
global glut of savings is pushing down rates around the world.

The unusual behavior of long-term rates first became apparent almost
a year ago. In May and June of last year, market participants were
behaving as expected. With a firming of monetary policy by the Federal
Reserve widely expected, they built large short positions in long-term
debt instruments in anticipation of the increase in bond yields that
has been historically associated with a rising federal funds rate. But
by summer, pressures emerged in the marketplace that drove long-term
rates back down. In March of this year, market participants once again
bid up long-term rates, but as occurred last year, forces came into
play to make those increases short lived.

But what are those
forces? Clearly, they are not operating solely in the United States.
Long-term rates have moved lower virtually everywhere. Except in Japan,
rates among the other foreign Group of Seven countries have declined
notably more than have rates in the United States. Even in emerging
economies, whose history has been too often marked by inflationary
imbalances and unstable exchange rates, access to longer-term finance
has improved. For many years, emerging-market long-term debt
denominated in domestic currencies had generally been unsalable. But in
2003, Mexico, for example, was able to issue a twenty-year maturity,
peso-denominated bond, the first such instrument ever. In recent
months, Colombia issued domestic-currency-denominated global bonds. As
rates came down worldwide, dollar-denominated EMBI+ spreads over U.S.
Treasuries receded to historically low levels, before widening modestly
of late.